Tuesday, February 20, 2007

Seigniorage Explained

Seigniorage is the mechanism of raising funds by printing of currency for Government spending.
For e.g. if the Reserve Bank of India mints 1 Crore - 5 Rs currency notes (i.e. 5 Crore Rs. worth) and assume the cost of manufacturing each note is 1Rs. So the Reserve Bank raises 4 Crore Rs in this Seigniorage process. This money can be used for all Government Fiscal spending. The catch here, what is the effect of unregulated Seigniorage? Can the government just keep on minting notes to counter the fiscal deficit and to fund government related spending?

You may recall from Indian History one of the blunders commited by Mohammad Bin Tughlaq! He was extremely interested in Coinage and minted numerous Brass and Copper coins. Being commonly available metals, every house in India started minting their own coins (i.e forged coins). The supply of currency increased so much that it threatened economic collapse through increased inflation. The Sultan had to buy back all the currency from the public (including the forged ones) by paying in bullion/gold.

Therefore the main consequence of expansion of money supply is Inflation. Inflation as we know means that all our money deposits and funds that we possess become lesser in value.

Thus we can see the need for controlling monetary expansion and ensuring the value of currency. This regulation is done by Central banks and regulatory bodies such as Reserve Bank of India and MAS (Monetary Authority of Singapore) etc.

Wow economics is damn interesting aint it!


Anshul said...

sign.. another one lost to the dark side... too many banks in the world :D

esu said...

:D yup I agree too that thr are too many banks! maybe am the spy ;)